Wealth and Poverty

Before completing our examination of wealth and poverty, there are a few related topics to cover: general spending patterns, consumer debt, and inflation.

Where It Goes

As I mentioned earlier, there are three broad classes of personal consumption expenditure: durables, nondurables, and services. Table 11.7 shows the dollar amounts of spending and the growth rates in these categories for 1977 and 1993, and the projected amounts for 2005.

As the table shows, consumers spend most of their money on services. The five largest service expenditures are housing, health care, financial services, utilities, and transportation. Spending on nondurables—food, beverages, clothing, toys, and so on—is the next largest category. Although spending on durables—motor vehicles, furniture, appliances, home computers, and so on—is the smallest, it is the fastest growing category of spending.

As household income falls, the percentage of income spent on necessities such as food, housing, utilities, and transportation becomes larger. This leaves little or nothing to save, and little to spend on durables such as new cars, furniture, and appliances. Therefore, much of the growth in spending on durables has been fueled by educated, higher income baby boomers purchasing vehicles, as well as homes and condominiums that require furniture and appliances as they have moved through adulthood.

New Highs in Deep Debt

American consumers use large amounts of credit. Consumer credit takes two basic forms: mortgages, which are used to buy real estate and are secured by the homes, condominiums, or other property being purchased; and consumer loans. Home-equity loans, which are personal loans secured by the equity in houses and condominiums, may be lumped in with mortgages. Consumer loans include both secured loans, such as auto loans, and unsecured loans, such as purchases made with credit cards.

EconoTalk

A secured loan is one in which the borrower provides a tangible or financial asset—such as a home, car, boat, stocks, or bonds—to the lender as collateral. In the event the borrower cannot repay the loan, the lender takes possession of the collateral and sells it to recoup the borrowed money. An unsecured loan is one on which the borrower provides no collateral.

Over the past 10 years, consumer debt in all forms has hovered around record levels, both in absolute terms and as a percentage of income. Mortgages to finance America's widespread homeownership are one reason, but so is the proliferation of credit cards and other installment debt. Growth in these borrowings has not been fueled only by people trying to make ends meet. Debt for the top 20 percent of U.S. households reached 120 percent of disposable income in 2002, compared with 100 percent in 1995. In the lower 80 percent of households, consumer debt stood at about 80 percent of disposable income in 2002, up from 70 percent in 1995. In each case, the 1995 levels were already high by historical standards.

The consequences of high consumer debt are twofold. First, it usually indicates a low rate of savings, and that is indeed the case in the United States. Second, when a recession results in fewer working hours and lower incomes, consumers can find repaying their debt difficult or even impossible. Indeed, according to the October 9, 2002 Wall Street Journal, auto repossessions, personal bankruptcies, and mortgage foreclosures were all at or near their highest levels in decades.

Moreover, consumers may also find it difficult to maintain, let alone increase, spending while carrying this debt burden. That can prolong lackluster economic growth or even contribute to a recession. Also, if interest rates rise, many consumers who had difficulty making debt payments at lower rates, may find themselves unable to do so at higher rates.

Nonetheless, many economists feel that American consumers can handle their debt, even at these levels. They point out that many people have come to accept debt and interest payments as part of their household expenditures. They also point out that incomes generally keep growing and that interest rates (except on credit cards) have been quite low for the past five years.

Inflation Hurts—and Helps

Except in times of stagflation, incomes generally rise during periods of inflation. But if incomes are not rising as fast as prices, then inflation is eroding the currency's purchasing power. This hurts everyone, wealthy, middle class, and poor, but can make life especially hard for the poor.

That's because of a second effect of inflation. During inflation, the value of assets, particularly real estate but also financial assets such as stocks, generally rises. This rise in asset values helps the wealthy and the middle class because they own real estate and stocks. The poor do not. The rise in asset values in the 1990s produced what is know as a “wealth effect,” which occurs when even people who don't sell their homes or portfolios feel wealthier because they are wealthier on paper. As a result of the wealth effect in the 1990s, consumers probably spent (and borrowed) more freely than they otherwise would have.

Price stability, along with high employment, are the goals of government economic policy. A stable currency enables everyone, wealthy or poor, consumer or businessperson, debtor or creditor, to make better, more confident financial plans and decisions.

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